For a 7-year annual bond with a coupon rate of 8%, par value $100, and current market price $120, what is the cost of debt before tax?

Expert Solution

Cost of Debt = [Coupon + Pro-rated Discount]/[(Purchase Price + Redemption Price)/2]

Where,

Coupon = Par Value*Coupon Rate = 1000*8% = 80

Pro Rated Discount = [(Redemption Price-Purchase Price)/Period to Maturity] = [(100-120)/7] = -2.857

Redemption Price (assuming at par) = 1000

Therefore, Before Tax Cost of Debt = [8-2.857]/[(120+100))/2] = 5.143/110 = 0.046753 = 4.6753%

jeff jeffy answered 2 years ago

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